Further to my post Friday night (Would you short this?) From reading the comments, I can see that a lot of my readers got it. The chart is the AUDCAD currency cross. While this currency pair shows the Australian Dollar to be vulnerable to its Canadian cousin, the loonie, it brings up another mystery.

First of all, the pair may not be as technically vulnerable as it initially appeared because it hit a 50% retracement level on Friday despite breaking down from major multi-year support.

I understand how the hedge fund community seems to have piled into the AUDUSD short as the Aussie Dollar has gone into freefall for the last few weeks. The short position has been highly profitable in a very short time.

Here’s the head scratcher. Why isn’t its Canadian cousin similarly weak against the USD? The structure of the Australian and Canadian economies are very similar as they are both resource based and both about the same size.

Admittedly, Canada did see some surprisingly positive economic releases last Thursday (Ivey PMI) and Friday (employment). On the other hand, how long will it be before all the Aussie shorts pile into a loonie short position as an alternative, especially when the CADUSD remains in a long-term downtrend and it hit a Fibonacci retracement level Friday and backed off? For reference, see these bearish posts on the Canadian Dollar from Sober Look (Canada’s latest job report is a mixed blessing) and FT Alphaville (Canada’s grizzly outlook).

Just asking.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Further to my last post (see Sell in May?) I am seeing more negative divergences that create more concerns for the bull case. The recent rally, which has been led by the golds and deep cyclicals, have all the appearances of a dead cat bounce rather than the start of a sustainable advance.

Last week, I suggested that traders should watch the silver/gold ratio for signs of a sustainable rally (see Watch silver for the bottom in gold). The idea was that silver, being the more volatile poor man’s gold, should display positive relative strength against gold and lead a precious metal rally if these metals are in the process of making a sustainable bottom. Look at what’s happened to the silver/gold ratio since then:

We can see how the oversold rally developed by analyzing the price charts of the gold and silver ETFs. GLD has certainly staged a classic capitulation and rally pattern to fill in the gap left by its recent freefall:

But what about silver? Sure, this poor man’s gold rallied, but the rebound has been weak and the gap was not filled, which suggests to me that this advance is an oversold rally and the next major move in precious metals is likely to be down.

As confirmation of the bearish commodity trend, the entire industrial metals complex remains weak despite the rebound in gold and oil:

In my previous post, I also wrote about watching the AUDCAD currency cross rate, with the premise that the Australian Dollar is more sensitive to growth in China and the Canadian Dollar is more sensitive to growth in the American economy. A breach of the uptrend in this cross rate would would be a signal that the market’s belief that Chinese growth is slowing, which would be negative for the global growth outlook. The breakdown in this currency pair cannot be regarded as good news for the prospects of Chinese growth.

Another concern is the disappointing South Korean April exports, which were just released and missed expectations at 0.4% compared to estimates of 2.0%. The South Korean economy is regarded as cyclically sensitive as the country is highly exposed to trade with China and Japan.

In addition, Cullen Roche at Pragmatic Capitalism recently pointed out that the Citigroup Economic Surprise Index is turning down in every major region in the world. As a reminder, a economic surprise index reading below zero is indicative of more misses than beats on economic data. Falling surprise indices around the world suggests, therefore, that global economic growth is starting to stall.

As we wait for the decisions of the Federal Reserve and ECB this week, it will be a test of market psychology of whether bad news is good news, i.e. economic slowdown will lead to central bank stimulus, which is bullish, or bad news is bad news.

Non-confirmation of SPX new highs
Moreover, with the SPX making new marginal highs, I am not seeing the breadth confirmations from the 52-week highs and lows. While these kinds of breadth divergences can last for months, it nevertheless raises a red flag about the sustainability of this stock market rally.

Here’s another puzzle. If the stock market is making new highs, why is the VIX/VXV ratio (which I described in a previous post here and first pioneered by Bill Luby, see his original post) sitting at only 0.91, which is barely below my “sell signal” mark of 0.92? What is the term structure of the option market telling us?

This is not investment advice
One final point. I have outlined a number of negative divergences that suggest a bearish tone for stocks, but I have not outlined the timing of any trades. In my last post entitled Sell in May? I sketched out a number of likely triggers for to get more defensive. Since then, I have had a number of emails and other responses asking if and when I would write about when those events are triggered and, by extension, when it’s time to sell or short the market.

Let me make this very, very clear: Those triggers are just a set of suggested triggers. It will be up to each individual reader to make up his or her own mind as to what to do if and when each event is triggered. Don’t expect me to hold your hand and shout “sell” for you. You are responsible for your own portfolio and your own profit and loss statement.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The IMF recently released a report on China that declared the RMB to be moderately undervalued against the USD [emphasis added]:

Currency appreciation continues to be an important component of the package of reforms needed to transform China’s economy. A stronger renminbi would increase household purchasing power, help expand the service and other nontradable sectors, boost the labor share of income, and facilitate financial sector reform. The recent widening of the intraday trading band is an important step in this regard, as it will allow the market to play a stronger role in determining the exchange rate. Using this increased flexibility would also have the benefit of allowing for a more independent monetary policy. As reserves are well above all standard metrics and the currency is moderately undervalued, the real effective exchange rate should be allowed to continue appreciating by reducing intervention over the medium term.

This view of the CNYUSD exchange rate equilibrium represents conventional wisdom. China’s currency is slightly undervalued against the Dollar and she needs to continue to take incremental steps to bring the exchange rate into fair value.

Could the RMB fall?
What if conventional wisdom is wrong and CNYUSD were to fall upon further exchange rate liberalization? Andy Xie has observed that capital is fleeing China because of a weakening economy [emphasis added]:

Emerging economies face capital outflows. Between 2009 and 2011, low interest rates in developed economies sparked massive flows of hot money into emerging economies. The hot money fueled asset inflation and spiced up economic growth too. The latter gave the perception of emerging economies decoupling from developed ones and incited even more inflow. The asset inflation eventually sparked general inflation, which slowed economic growth and diverted money from asset markets. The resulting asset deflation further decreases economic growth. Hot money is now leaving because it sees the unsustainability of the growth dynamic in emerging economies.

The Indian rupee and Brazilian real have declined by one-fifth from their recent highs, reflecting pressure from capital outflows. Because China has a controlled exchange rate, the outflow has come later, as investors believed in the safety of a government-supported exchange rate. The weakening economy this year appears to have sparked expectations of yuan depreciation. The government support of the exchange rate has become an accelerator for capital outflow, as it is increasingly viewed as a subsidy for early leavers.

Similarly, Izabella Kaminska at FT Alphaville has reported on a USD shortage in China, which has been also interpreted as funds flow leaving the country:

A while ago, we dared to suggest that a new trend was emerging in China’s foreign exchange operations. Instead of being a net buyer of foreign currencies from the market — and conducting monetary policy operations in line with that position — the Chinese state was becoming a net seller of foreign currencies onto the market, and adapting its monetary policy accordingly.

A natural outcome of there not being enough foreign currency inflow into the country. But also of yuan outflows, and fears that the yuan may depreciate more generally.

Let’s suppose that Washington got it want from the Chinese in the form of greater exchange rate liberalization, but instead of rising against the USD, CNY fell instead. How would Congress react?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The market shrugged off a few tape bombs yesterday in a break of a key technical point on dollar-euro (1.25) and the very weak consumer sentiment number. The strong close on a 90% upside breadth day looks promising, but weak volume in most sectors and financials specifically suggests there is not much conviction behind the buying.

There is little doubt the US looks mountains (of debt) better than Europe right now and it is bound to catch some money flow out of the euro as it leaves the region, but by no means is the economy healthy if we back out the artificial stimulus of the engineered yield curve. One example would be that bank profitability with a normalized yield curve would be 20-30% less at a minimum. And if corporate yields were not as low as they are, margins would be a good 10% lower in many companies as well. So take 20% off the $100+ in S&P earnings and the market is no longer cheap at 18x un-stimulated and un-sustainable normalized trailing earnings.

In my last post, I wrote that I was watching the European bourses and the Hang Seng Index for signs of whether we are likely to see a continuation of the bull move or a consolidation period.

The preliminary verdict is consolidation and correction. You can tell the short-term tone of the market by how it reacts to news. On the weekend, China unexpected cut reserve requirements by 50 bp. The Shanghai Composite rallied on the news, but the Hong Kong market was unable to hold its gains and finished the last few days beneath a key technical resistance level.

In Europe, we saw the Greek bailout deal finalized late in the night. Markets staged a mild rally on the news and then sold off. The Dow rallied to kiss the 13K level and wound up roughly flat on the day. Does this sound like a market where the bulls are in control or does it sound like they’re exhausted?

In the wake of the easing of financial tensions in the eurozone, can anyone explain to me why the EURCHF exchange rate hasn’t rallied and appears to be slowly declining to the 1.20 level where the SNB said it would defend?

The Swiss Franc has long been regarded as a safe haven and the EURCHF rate is a measure of risk appetite so the above chart appears to be anomalous. What does the FX market know that the equity markets don’t know?

I generally agree with Barry Ritholz’s scenario for the market, though I believe that the Fed is likely to be proactive on QE3:

If the past is prologue (and that cannot be relied upon), we could see a scenario something like this (Note: Wild ass guessing to follow). Markets kiss 13,000, pullback and consolidate. But they are not overbought sufficiently for anything more serious than a modest retracement, and so they continue higher for several months, until the % of stocks over 200 day MA is near 90% (they are at 75% today). That takes us somewhere between March and June. The next sell off begins, lopping 25% or so off of the SPX. The Federal Reserve waits until after the November election to introduce QE3, and the cycle starts anew.

My base case scenario calls for a short (1-3 week) consolidation phase and a grind upward. After that, we’ll have to watch how events unfold.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The past week ended with a string of better-than-expected data releases from key major economies, suggesting the global recovery may avoid a more worrisome downturn. Mostly better than expected PMI’s from Europe, UK, China and the US were supplemented on Friday by a much stronger US employment report than was expected. We’re cautiously optimistic that the better US jobs report is a valid signal that the US recovery is improving, but we’re also aware that January employment numbers are especially volatile due to seasonal factors, and subject to major revision. The decline in the unemployment rate in the January report, in particular, is also suspect due to the inclusion of new population data from the 2010 census. The best way to interpret the data is as though the unemployment rate was already at 8.3% in December as opposed to having declined in January.

The series of more upbeat data allowed the current ‘risk on’ rally to extend further, but with a few notable twists. Of special note is that markets continue to differentiate between currencies based on the prospects for respective central banks to expand their balance sheets further (quantitative easing or QE). We saw this last week following the Fed’s lower-for-longer rate pledge and Bernanke’s mention that QE3 remains an option, which sent the greenback lower across the board. Following Friday’s jobs report, which we think delays (at the minimum) potential Fed QE3, the USD rebounded against EUR and GBP, but lost ground to other major currencies like AUD, CAD, and NZD. The key there is that EUR and GBP, whose central banks are expected to continue asset purchases/balance sheet expansion, also lost ground to AUD, CAD and NZD, whose central banks are not expected to initiate QE. Gold prices also declined sharply on Friday, revealing the yellow metal’s strong relationship with the likelihood of Fed QE3.

We expect this dynamic to continue to influence near-term trading conditions and incoming data will remain an important driver. Next week doesn’t see too much in the way of top-tier data for the majors, but what does come out could have a larger impact than normal (e.g. Australian retail sales, German factory orders/industrial production, Canadian Ivey PMI, and UK industrial production).

Still waiting on a Greek debt deal

Another week comes and goes with no final deal in place to secure Greece’s next round of bailout funds. EU officials’ comments continue to suggest that a deal is nearly complete, with the final sticking point being the amount of public sector participation in debt losses, meaning how much of a loss national governments and the ECB will have to swallow. Assuming a satisfactory deal is reached on the Greek debt swap, what then?

We would expect a final flurry of risk-positive movement as fears of an imminent Greek default are quashed, but we think such a moment may also represent a near-term peak in the current risk rally. For if a deal is reached, we think it will likely be the highpoint in terms of good news in the Eurozone debt crisis. Markets are likely to conclude that even with a Greek debt deal, Greek debt levels are still unsustainable in the long-run. And this also assumes there is no messy rebellion by some Greek debt holders and CDS are not triggered. Moreover, despite better than expected Jan. Eurozone PMI’s, the outlook is still for further weakness in Eurozone growth in the months ahead, which will likely come back to undermine European debt markets yet again.

While there has been some marked improvement in Italian, Spanish and Portuguese bonds in the last week, we’ll be looking to how much of the decline in yields was due to ECB purchases. The ECB will announce the total amount of bond buys made in the last week on Monday at 0930ET/1430GMT. If they were forced to step up purchases significantly over recent weeks, the nascent calm in European debt markets may not last.

In EUR/USD, we continue to watch the recent 1.3000/1.3250 area as a consolidation range, with a break signaling the next directional move.

Central banks’ decisions on tap

Next week sees interest rate and policy decisions from the RBA, BOE and ECB. The RBA is first up on Tuesday afternoon local-Sydney time and markets are expecting a 25 bp rate cut from 4.25% to 4.00%. There is some minor risk of a larger 50 bp cut, as the RBA does not expect banks to pass on to customers the full 25 bps if it only cuts by that much. There is also a small risk that the RBA stays on hold, potentially in light of recently more upbeat global data and calming in the Eurozone debt crisis. Regardless, AUD is not trading on interest rate dynamics at the moment, so we would look to the overall risk environment to gauge AUD’s outlook.

The BOE is first up on Thursday morning and they are expected to hold the benchmark rate steady at 0.50%, but also to initiate a third round of asset purchases. Markets are mostly expecting a smaller round of GBP 50 bio, with a minority expecting another round of GBP 75 bio. In light of some surprising strength in recent UK data, we think the risk is that the BOE does nothing at this meeting, which could see GBP strengthen briefly. Sterling also appears to be defying QE speculation in recent days and GBP/USD is nearer to its recent highs. However, we would note cable is having difficulty extending gains beyond 1.5900, and we are watching for a daily close below the 1.5765 daily cloud top to suggest a potential failure and the start of a reversal lower.

The ECB is also up on Thursday, but are expected to keep policy on hold. ECB Pres. Draghi is likely to point to slightly better PMI’s as a further sign that 4Q was potentially the nadir for the Eurozone, but will also certainly note that downside risks remain. Overall, we don’t think the ECB meeting/press briefing will drive EUR, but that the Greek outcome and risk sentiment will be more important.

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